The Financial Management of Hospitals and Healthcare Organizations
Michael Nowicki
Chapter 6
Cost Accounting
Joe Riley
June 21, 2007
Outline
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Methods of Classifying Costs
o Accounting Function
o Management Function
o Traceability
o Behavior
o Relevance in Decision Making
Methods of Allocating Costs
o Organizational Chart
o Revenue Center Identification
o Accounting System
o Workload Statistic
o Cost Allocation Methods
 Direct Apportionment
 Step-Down Apportionment
 Double Apportionment
 Multiple Apportionment
Methods of Assembling Costs
o Responsibility Costing
o Full Costing
o Differential Costing
Methods of Determining Product Costs
o Ratio of Cost to Charges
o Process Costing
o Job Order Costing
o Activity-Based Costing
o Standard Costing
Relationship of Costs to Volume and Revenue
Chapter Summary
Cost Accounting involves analyzing costs using various methods for classifying costs, allocating costs, assembling
costs, and determining the costs of products and services. Cost accounting is used to provide management with
cost information for reasons such as cost management, setting charges, and profitability analysis. Cost
Accounting has dramatically increased in importance and complexity since 1983, due to the rapid growth of
managed care.
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There are several Methods of Classifying Costs:
1. Accounting Function – costs can be broken up into financial (revenue and expenses) or managerial
(present and future costs) functions.
2. Management Function – costs can be broken up into operating (associated with producing the product
or service) and non-operating (associated with supporting production) costs.
3. Traceability – broken into direct (traced directly to department product, or service), indirect (can’t be
traced), full (direct and indirect costs combined), and average (divided by products or services) costs.
4. Behavior – broken into variable (vary directly to changes in volume), fixed (remain constant to changes
in volume), semi-variable (vary incrementally to changes in volume), and marginal (changes in costs
related to changes in volume) costs.
5. Relevance to Decision Making - broken into true costs, controllable costs, uncontrollable costs,
differential costs, sunk costs, opportunity costs, relevant costs, actual costs, and standard costs.
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Allocating Costs is the process of moving indirect costs, and some direct costs to departments that
generate charges. Several Methods include:
o Direct Apportionment
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NR
R
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Pros: considers costs or NR depts. working for other NR depts.; can be hand calculated
Cons: does not consider revenue depts. working for other revenue depts.
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patient
Double Apportionment
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Pros: simplicity
Cons: does not take into account the costs of nonrevenue depts. working for other
nonrevenue depts.
Step-Down Apportionment
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patient
patient
Pros: considers costs or NR depts. working for other NR depts.; also considers costs of R
depts. working for other R depts.
Cons: requires a computer to calculate
Multiple Apportionment
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Pros: most accurate method
Cons: requires a computer with significant memory and significant computer time
There are 3 Methods of Assembling Costs:
o Responsibility Costing – assembling costs by cost centers.
o Full Costing – assembling direct costs and allocated share of indirect costs to determine a product or
service’s cost
o Differential Costing – assembling costs using incremental and differential costs.
There are 5 Methods of Determining the Cost of Products/ Services:
o Ratio of Cost to Charges (RCC) – relates cost to its charge. Calculated by dividing an organization’s
total expenses by the gross patient revenue.
o Process Costing – divides the full costs of the organization or department during a given period by
the umber of products/ services produced during that period.
o Job Order Costing – samples the product’s actual direct costs and develops a relative value unit
(RVU).
o Activity-Based Costing – uses cost drivers to assign direct and indirect costs to products (RVU).
o Standard Costing – not a method of determining costs, but a method of establishing benchmark
costs.
The Relationship of Costs fo Volume and Revenue (Break-even Analysis)
o PROFIT = REVENUE – EXPENSES
o Break-even quantity = total fixed costs / (charge – variable costs per unit)
o Contribution Margin Percentage = (charge – variable expenses per unit) / charge
o Break-even point ($$) = total fixed costs / contribution margin percentage
Terms & Definitions
Cost Accounting
A field of accounting that studies costs including methods for identifying,
classifying, and allocating costs.
Direct Costs
Costs that can be traced directly to a department, product, or service.
Indirect Costs
Costs that cannot be traced directly to a department, product, or service.
Full Costs
Include both direct and indirect costs.
Variable Costs
Costs that vary directly and proportionately to changes in volume.
Fixed Costs
Costs that remain constant in relation to changes in volume.
Sunk Costs
Costs that have already been incurred and thus will not be affected by
future decisions.
Break-Even Point
The volume in units at which the total revenue line intersects the total
cost line. OR where total cost equals total revenue.
RCC – Ratio of Costs to Charges
RVU – Relative Value Unit
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Chapter 6